Remember all those stories about how the nose dive in financial markets was the first big test for Federal Reserve Chairman Ben Bernanke, the academic economist who was still developing his feel for the interplay between the central bank and Wall Street?

Well, it turns out that was only a midterm. The final exam begins today, when Bernanke will either show that he is capable of standing up to the insatiable demands of Wall Street, or that he is so spooked by the prospect of being blamed (unfairly) for triggering a financial meltdown that he puts the short-term interests of big banks and investment houses before the long-term interests of the global economy.

It's not a whole lot more complicated than that.

Up to now, the Fed has responded pretty much as it should have to the unfolding credit crisis. It has stepped in when necessary as a lender of last resort to the banking system. And it has shifted its primary concern from inflation to recession, punctuating that change in emphasis with a 50-basis-point reduction in the federal funds rate.

You can quibble with the program, but it's fair to say it has had the desired effect: Credit markets that had seized up have begun to trade again and new credit is being extended to worthy borrowers at reasonable prices. But now that the temporary liquidity crisis has passed, the Fed has to send the equally important signal that it won't allow investors and lenders to avoid dealing with the massive credit problems that triggered the liquidity shortage in the first place.

In public, the Fed likes to create the impression that it doesn't base its decisions on how markets might react, and focuses only on inflation and economic growth and what's best for the "real" economy. But we know from meeting transcripts, as well as the amount of time and attention Fed officials spend in communicating with the markets, that this is a convenient fiction.

We also know that there is no compelling economic case for another rate cut at this meeting.

Even if you believe, as some of us do, that the bursting of the housing and credit bubbles will eventually drag the economy into recession, there is little evidence that this is happening yet. And when the economy does begin to hit the wall, there is little the Fed will be able to do, or should do, to prevent it: It is part of the economy's natural self-correcting process. In any case, waiting another month or two wouldn't have much of an effect on the economic outcome either way.

But what a rate cut surely would do is to encourage investors and bankers in their belief that the Fed is so desperate to avoid a credit crunch that it is willing to reinflate the bubbles and keep the party going anyway it can.

Think about that for a minute. If the Federal Reserve were so worried about a major U.S. recession that it embarked on a series of interest rate cuts, do you think rational investors would be pushing stock prices to record highs both in the United States and abroad? Or piling into highly cyclical commodities futures? Or trying desperately to complete highly leveraged corporate buyouts at premium prices?

Of course not. If a recession were on the horizon, they'd be selling stocks, not buying. And the interest rate spreads between risk-free Treasury bonds and the bonds of private companies whose risk of default would increase with recession would be widening, not narrowing.

In fact, Wall Street has largely discounted the risk of recession, just as it has discounted the risk of inflation, discounted the rise in oil prices and discounted the fall of the dollar. In short, it remains in deep denial about the fix that it is in.

Sure, Wall Street's executives and traders are painfully aware of the $30 billion dollars in write-offs that have cut deeply into this year's profits, or wiped them out completely.

They know that the chief executives of Merrill Lynch and UBS have already lost their jobs, along with the heads of investment banking and risk management at several of the larger houses.

They know that the rating agencies are in the process of slashing the credit ratings of hundreds of billions of dollars in mortgage and other asset-backed securities from AAA to junk.

And they know that if Citi and other big banks can't refinance the hundreds of billions of dollars of short-term IOUs issued by their off-book, offshore entities, they will have to incorporate those entities into their books and write off billions of dollars more.

All of which is why they are so desperate for someone to step in and magically make it all go away. Now desperation has turned to hope, hope has crystallized into expectation, and that expectation -- of a Fed rate cut -- has been priced into every stock, bond, commodity future and credit derivative.

But won't the markets react badly if those expectations are dashed? For a few days, or even a few weeks, almost certainly they will. But if the Bernanke Fed doesn't respond to this challenge by showing that it cannot be pushed around by the markets -- that it is willing and able to take the heat and insist that Wall Street deal with its problems -- the Fed will almost certainly find itself in the same position six weeks from now, and six weeks after that, and six weeks after that.

It would have been better for everyone if the Wall Street herd hadn't tried to box in the Fed by creating these unrealistic expectations. It would have been better if the markets were focused instead on the unsolved problems in the financial sector, the falling dollar, rising oil prices and the continued deterioration of the housing market. But that's not the way it worked out.

So now, if the Bernanke Fed wants to retain its credibility and independence -- if it wants to have the flexibility to cushion the coming downturn without stoking inflation or creating a new set of bubbles -- then there is only one thing to do today: